Rite Aid Corp (RAD) 2006 Q1 法說會逐字稿

Good morning. At this time I would like to welcome everyone to the Rite Aid first quarter conference call. [OPERATOR INSTRUCTIONS] Thank you. Mr. Twomey, you may begin your conference.

Thank you. Good morning everyone and welcome to our first quarter conference call. This is Kevin Twomey and I am the Chief Accounting Officer and I am also responsible for Investor Relations. On the call today with me are Mary Sammons, our President and CEO and John Standley, our Senior Executive Vice President and Chief Administrative Officer and Chief Financial Officer. Our agenda for today's call will be as follows: Mary will give us an overview of first quarter operations. John will review the first quarter financial results and comment on our fiscal 2006 guidance. And then we'll take questions.

But before we begin I'd like to remind you that today's conference call includes forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements. The factors that could cause actual results to differ are described in our fiscal 2005 annual report on Form 10(K) and our periodic reports on Form 10(Q) and Form 8(K) if any. Consequently all the forward-looking statements made during this call are qualified by these and other factors, risks and uncertainties.

Also during today's call non-GAAP financial measures are mentioned. The definition and purpose of using these measures are described in the Form 8(K) we furnished the SEC this morning. The Form 8(K) can be accessed through our Website under the, Our Company and Investor Info tabs. You are also directed to consider other risks and uncertainties discussed in documents we filed with the Securities and Exchange Commission. Now that we have covered the administrative aspects of the call let's begin. Mary?

Thanks, Kevin. Good morning, everyone and thank you for joining us today to discuss our first quarter results. We reported a profitable quarter with net income of 33.4 million or $0.05 per diluted share, compared to net income of 63.7 million, or $0.10 per diluted share in last year's first quarter. Adjusted EBITDA declined by 9% over last year, primarily because of weaker pharmacy sales. As expected our pharmacy comps continue to be negatively impacted this quarter by the shift in the United Auto Workers Health Plan plan to mandatory mail. An increase in SG&A as a percent of sales also had a negative affect on adjusted EBITDA as we again made the decision not to reduce service levels in our stores to counteract the sales decline or to reduce our promotional spend.

The good news is that even with cooler weather and heavy rains on the West Coast our front end same store sales returned to positive territory. Same store sales decreased 0.3% in the quarter. Pharmacy same store sales were down 1.2% compared to first quarter a year ago. But the gross margin rate was up due to more sales of higher margin generic and purchasing improvement. Dispensing of new generics [stamped up] comps by 228 basis points while the percentage of total generics dispensed increased 428 basis points compared to the prior first quarter. Our pharmacists continued to do an excellent job of educating patients about the value of generics, saving patients as well as third party payers money on prescriptions.

The later cough, cold and flu season generated strong increases in related therapeutic categories but safety concerns contributed to slower sales of antiarthritics, psychotherapeutics and hormone replacement therapies. Antihistamines and gastrointestinal prescriptions are still being negatively affected by OTC switches. Competitive openings in selected markets also impacted results. We have strengthened our competitor response and this should help minimize future impact.

Progress on our pharmacy initiatives continued as we announced that Rite Aid is now able to provide pharmacy benefit management services to employers, health plans and insurance companies. Our PBM called Rite Health Solutions is using ProCare RX to provide back office support. And we should have our own national sales and marketing team in place by fall. Our goal is to provide 90-day prescriptions at retail as a low cost alternative to mail order to keep driving business into our stores. Rite Health Solutions also gives us more options with managed care plans for additional business. During the quarter we aggressively pursued prescription file buys, surpassing the number of file buys during the first quarter of last year.

Since last week we completed the purchase of the Shelly's Drug Store chain in Philadelphia, one of our strategic markets. We kept two stores and transferred the prescription files from four others . Enrollment in our Living More senior benefit and discount program which we launched at the end of February reached more than 1.4 million members. Our goal is to retain and acquire new senior customers by offering prescription and product savings with added health and wellness benefit of a quarterly newsletter with information targeted to the individual senior's healthcare needs. So far we are seeing larger than average market baskets from our Living More customers. We believe getting more seniors to shop Rite Aid will allow to us take even greater advantage of the 720 billion in new prescriptions, the new Medicare benefit is expected to generate over the next ten years.

We also are entering into separate preferred marking partnerships with three large insurance and managed care companies that have a substantial number of senior clients. Aetna, Coventry and United Healthcare and we'll work with them to educate seniors on the new drug benefit. We expect these alliances to also bring new senior customers to Rite Aid. While we will participate in only a select number of preferred marketing partnerships like these our goal is to be a provider in all Medicare Part D programs that makes financial sense for Rite Aid. During the quarter we saw statistically significant improvement in pharmacy customer satisfaction scores, which focus on the attributes that drive drug store customer loyalty. We also moved close to an agreement to pilot nurse practitioner services in a select group of markets in the fall.

On the front end, same store sales were up 1.4%. Core drug store was strong due to the late cough, cold and flu season. And we saw solid gains in the health and wellness related categories of home healthcare and diagnostic diabetics. A year and a half after its launch our diabetes initiative continues to drive significant increase in that category. We also saw gains in health and beauty care and consumables with more modest increases in general merchandise. Our GNC departments continued to bust the trend of declining vitamin sales and we also added 93 new private brand SKU's in the quarter.

We did see a decrease in summer related categories where cooler weather had an impact on results. And while photo and film sales again declined digital sales continued to be much stronger than the overall category. We expect photo sales trends to improve as the customer gains confidence in digital development at retail and as we add new digital services. We recently announced that our West Coast stores will soon be selling disposable digital cameras as well as offer digital print to store online service. This means customers can order digital prints online at riteaid.com for one hour pick-up at their local Rite Aid store.

During the quarter we launched our health condition marketing programs with our allergy initiatives starting in May. Working with the American Academy of Allergy, Asthma and Immunology we developed an eleven page guide that gives recommendations for OTC medicines, tells patients what to ask their doctors about allergies and provides tips on allergy proofing your home. We've seen significant increases in all allergy related categories during this program. Our plan is to focus on a different health condition every quarter to strengthen the patient relationship with our pharmacist and promote sales.

Also in May we voluntarily moved all single ingredients pseudoephedrine products behind the pharmacy counter and announced that we will move all solid combination pseudoephedrine products behind the pharmacy counter by August 1. We did this to support law enforcement's effort to curb the rise in using certain cough and cold OTC products to make methamphetamines. We continue to work with our trade association and our lobbyist to get one standard nationwide bill covering regulation of these products that would preempt the wide variety of bills that states have introduced or already passed. So far we haven't seen any negative impact on sales in the cough and cold category from our proactive stance.

We opened 16 new GNC departments in the quarter, bringing the total of GNC stores within our stores to 1,065. You may remember we plan to add 300 additional GNC departments over the next three years. And we've completed 85% of the reset of our beauty quadrants adding a men's grooming section and placing more emphasis on spa products and professional hair and skin care and we will finish the rest of the stores this week. We believe this will increase our already strong beauty sales. Our new store development is well underway with 42 new and relocated stores already open or under construction as part of our goal to open 80 new and relocated stores this year. Our plan to remodel 200 stores this year is also on schedule. We have designed aggressive marketing and promotion plans around the grand opening of each of the new stores and advertising to promote the remodels.

And while SG&A increased as a percent of sales in the quarter we expect to see improvements in the remainder of the year from a variety of cost containment measures. As you can see from our release, we are revising sales and EBITDA guidance. While front end sales are recovering nicely, pharmacy sales are rebounding slower than we anticipated. While it is going to take time to get our pharmacy sales back on track, we believe our initiatives will position us well to take advantage of the increased growth in prescription sales expected from the Medicare prescription drug benefit. And to benefit from the substantial increase in new generics coming to market next year. Now I will turn it over to John.

Thanks, Mary. Total revenues for the thirteen-week first quarter were 4.22 billion this year compared to 4.24 billion last year, or a decline of 22.9 million. We operated 3,354 retail stores at quarter end, versus 3,374 stores at the end of last year's quarter, a net reduction of 20 stores. Same store sales declined 30 basis points for the quarter due to a 1.2% decline in pharmacy same store sales partially offset by a 1.4% increase in front end sales. Pharmacy sales were negatively impacted by lower inflation, higher generic mix, the continuing impact of mail programs and declining sales in certain therapeutic classes with safety concerns. Front end sales made solid improvement in the quarter due in part to the cycling of the impact of the west coast grocery strike. Gross margins, which are net of occupancy costs, were 1.08 billion or 25.6% of revenues for the first quarter this year versus 1.05 billion, or 24.8% of revenues last year.

The current quarter included a non-cash LIFO charge of 7.6 million versus a charge of 10.7 million in last year's first quarter. Excluding LIFO, the first quarter gross margin was 25.8% of revenue this year compared to 25.1% of revenue last year, an increase of 72 basis points. FIFO gross margin was positively impacted by both pharmacy and front end margin increases. Pharmacy margins were positively impacted by more generic scripts as a percent of total scripts and reduced inventory costs resulting from purchasing improvements. Partially offsetting these positive factors were lower reimbursement rates. Front ends margins were positively impacted by lower expenses related to product returns and slow moving product.

Selling, general and administrative expenses for the quarter increased as a percent of revenue by 94 basis points compared to the prior year. The increase is primarily the result of higher wage and benefit expenses, advertising expenses, repairs and maintenance expense and fees related to the utilization of the accounts receivable securitization facility; partially offset by litigation settlement income and lower depreciation and amortization expense. Non-cash stock based compensation expense, which is included in SG&A, was 4.9 million this year, versus 4.0 million in the prior year. We expensed the fair value of stock options granted.

Store closing and impairment costs were 15.5 million this year versus a credit of 4.6 million in last year's first quarter. The $20.1 million increase is primarily due to an increase in the number of stores closed and a decrease in the discount rate we used to present value the remaining lease payments on closed stores. Interest expense was 70.9 million for the first quarter versus 77.8 million in last year's first quarter, due to lower levels of debt and a lower cost to borrow under our new senior secured credit facility. Cash interest expense was 65.9 million this year versus 72.1 million last year, and non-cash interest was 5 million this year versus 5.7 million last year. Income before taxes was 47.3 million this year versus 68.8 million last year. Income tax expense for the second quarter was 13.9 million this year, which is net of a $7.8 million tax refund. The 13.9 million current quarter expense compares to a $5 million income tax expense for last year. The increase is due to the current year's recognition of deferred tax expense.

Net income for the quarter was 33.4 million or net income per diluted share of $0.05 compared to net income of 63.7 million or net income per diluted share of $0.10 last year. Adjusted EBITDA for the quarter was 203.6 million, or 4.8% of revenues, a decrease of 20.5 million from the prior year. The schedule attached to our press release reconciled our net income to our adjusted EBITDA total. Some details on cash flow are as follows: Cash flow provided by operations was 172.8 million this quarter versus 216.6 million last year. The decrease is primarily a result of decrease in adjusted EBITDA and a lower amount of income tax refund versus the prior year. For the quarter, we spent 41.8 million for property, plant and equipment and 7.9 million for script file purchases for a total of 49.7 million of CapEx in the first quarter. During the quarter we also completed the sale and lease-back of nine stores for net proceeds of $24.1 million. During the quarter we opened two new stores, relocated three stores, acquired one store, closed five stores and remodeled 47 stores.

During the quarter we redeemed 170.5 million of the 7 5/8% note at the scheduled maturity date in April. Liquidity continued to be strong. At the end of the quarter we had no outstanding borrowings under our revolver. Availability under the $950 million revolving credit facility was 838 million, reflecting outstanding letters of credit of 112 million. The $400 million accounts receivable securitization agreements continued to be an excellent source of liquidity and at the end of the quarter we've utilized the facilities for $150 million. Subsequent to the quarter we called the $150 million, 11.25% note at a redemption price of 105 5/8. The source of the funds for the redemption at the time of closing in July will primarily be a cash available in the accounts receivable securitization facility, although we may also utilize the revolver slightly. We will incur a $9.1 million pretax charge in the second quarter for the call.

Guidance for fiscal 2006 is revised as follows: We are now estimating fiscal 2006 revenues to be in the range of 17.1 to 17.4 billion, based on same store sales range of 0.5% to 2%. We are estimating fiscal 2006 adjusted EBITDA to be in the range of 675 million to 725 million, and our net income to be 31 million to 62 million, or $0.00 to $0.05 per diluted share. Attached to our press release is a table that reconciles our adjusted EBITDA guidance to our guidance for GAAP earnings. CapEx is estimated to be in the range of 350 million to 400 million for fiscal 2006, including approximately 80 new and relocated stores. CapEx estimates do not reflect proceeds for possible sale lease-back transactions. And EPS estimates do not include any tax benefit that may be realized due to reductions of the valuation allowance related to our tax NOL's Operator, we are now ready to take questions.

[OPERATOR INSTRUCTIONS]. First question comes from Steve Chick with J.P. Morgan. Mr. Chick your line is now open. Mr. Chick has withdrawn his question. Your next question comes from John Heinbockel with Goldman Sachs.

A couple of things. First quarter actually looked okay versus expectations particularly with respect to gross. I'm curious what you see in the second through fourth quarters that led to the reduction in guidance particularly this early in the year? And then I have a couple the follow-ups.

I will give you an answer on that one, John. If we look at our pharmacy sales, we would really I think have expected slightly more improvement than we saw as we finished the quarter. And based on that and really wanting to make sure that we keep doing the right thing to grow the pharmacy business, we took down our really our estimates there on the pharmacy side of the business. And give it a little bit slower build to get the sales back where they need to be and the markets that were affected primarily by the mail programs that we've talked about before. But also to strengthen our competitive response and to really do the things to improve customer satisfaction, which has been a real focus for us over the last number of quarters.

So you think some of it is increased investment in the pharmacy side of the business or no?

Well, I tell you, John, we are really focused on having the flexibility, having the guidance range that gives us the flexibility to do what we think we need to do to get these pharmacy sales going the right way.

We really ramped up our technician training programs through the first quarter. We are going to plan to continue to do that in the second quarter. So we believe that that's a real key also to achieving what we need to have that experience be in the pharmacy. So, we are making investment as well as doing the right things to improve customer satisfaction.

The other thing was that the gross really looked quite good compared to where you've been the last couple of quarters, stepped up sequentially year over year. What changed this quarter versus the last couple? Was it all generic? And did what changed 0 0 does that have some sustainability to it or is it kind of one time?

Well, I would just say that both front end and pharmacy had good quarters here. I like to put the two together in the same quarter, that's always a plus. On the pharmacy side, in a broad sense here we're always looking at reimbursement rates but there are some very underlying positive trends with generics. And some things on the purchasing side that are helpful. I would think those trends are generally going to continue. Although we are looking at reimbursement rates all the time. On the front end, it was just a lot of things, I think, going the right way. And, again, there is seasonality in the front end margin numbers that will have some impact as we go across the year.

And on the generics we had a significant improvement in the percentage of generics within our mix in the quarter. And it improved dramatically versus last year and we already had a really good rate then. But it also improved over the past quarter, over the last quarter of last year. So we continue to gain momentum there. And I think that's going to work really well for us as we move through this next few years as more generics come on board.

Alright. And then finally the lift you are getting, I don't know if - - how many of these you have, but the prototype remodels, how does the lift you are getting compare to what you were getting with prior remodels, both front end and pharmacy, is it significantly higher?

Well, we had really not done that kind of remodel in the past. Where we doing - - have been doing our remodels we've doing a couple hundred stores a year. They've taking the existing store and doing a regular remodel. Some of those have good increases. Some are just to stay kind of even with where you need to be because of competitors opening. We hadn't done a lot with new stores. But I can tell you that the customer satisfaction ratings out of the new store prototype, whether you look at intent to return, intent to recommend, increased shopping trips, market baskets, a view of the pharmacy are all extraordinarily positive.

And all 200 this year are --?

No, that's what I - - I wanted to clarify that. Generally many of the elements of the prototype are not yet in the remodel program. They will be as we get later into the year. And we are working through that aspect of the remodel program now. The most important thing was obviously to get the prototype developed, get it built, test it, make it is achieving what we want it to achieve. We're, I think very satisfied with what we got there. So, now we're in the process of adding those aspects to the remodel program.

Next question comes from Christina Boni with Credit Suisse First Boston.

Yes, good morning, everyone. My first quarter is with respect to competitive openings. I think Mary, you talked about competitive openings in certain markets. Can you give us a sense of what's going on out there? What you are seeing and what particular areas are you being most impacted?

I don't know if I will talk about specific areas but obviously we've had a lot of competitors over the past several years have opened a lot of new stores in markets that we operate in. And that's why it was also important for us to restart our whole growth engine and improve our density in those markets to be even more competitive in the future. And if - - I think it's just a cumulative effect. So it was really important for us to develop stronger competitor response tactics, which we have done. And which we will be using going forward. And like I said in my comments I think that will minimize impact. You'll always have some impact but I think we can do and are doing more to minimize it now going forward.

And you also talked about that your pharmacy, your customer service scores are going up, I believe. Can you talk about a little bit about what maybe is the setback, why comps are taking longer to ramp up than what you had anticipated? Anything going on in the pharmacy that you are disappointed at where you are at at this juncture?

Well, I think we mentioned that we as a saw some decrease in our customer satisfaction scores last year as we rolled out our new pharmacy system. We're getting really good reviews on our system in terms of flexibility, use and just really creating a better work flow and environment and all sorts of benefits too for the patient. So, we think we're past all of that. But it still takes you time to get your satisfaction built back up. And we believe over time, what we're able to do through the new system is going to help us get better at delivering what customers expect in the pharmacy. It's just taken us a little longer to get past the full effect of mail order because certain - - in certain regions that are really having the - - still have not picked up as much as we would have expected. So, we are going to continue to work our strategies there. Be even more aggressive with fly buys where they make sense in those markets. And work on the things we control, so we get through the full brunt of the mail order and get our satisfaction really where it needs to be.

I think the good news is that we've made a lot of investment over the last year, both in CapEx and even in training and just payroll costs. To get this pretty nice pharmacy system out there. And from a management perspective one of the things I really like about it is the level of information that we now have available to us to look into each individual pharmacy and see how it's performing. It really gives us the opportunity to address any issues or problems that come up on a much more timely basis. And I think as we use learn to use that information and that tool, we're going to get at the key aspect that drives the pharmacy for us. Which is the key drivers for customer satisfaction; filling scripts on a timely basis, that kind of thing. And so I think we are very well-positioned. We've made some painful investments that impacted our top line and impacted our earnings a little bit, unexpectedly. But we've got ourselves kind of around some of the right spot here to go forward. And I think you have to be, for us, we are pretty excited about that.

And is July really the first month that we should look to in terms of cycling UAW? Is July the right month to look at?

Yes. I think you got through the full effect of it through the June month. And so July should be really the first real key month in terms of whether we have cycled that.

Okay. And then finally, just on the sale lease backs you said there were nine stores you did in the quarter. Would you anticipate doing any further sale lease backs this year or is that a good number for the full year in terms of the 24 million in net proceeds?

No, we;re looking at other potential transactions.

Okay. Great. Thanks so much.

You're very welcome.

Your next question comes from Bob Summers with Bear Stearns.

Good morning. You guys have talked about in the past small multi-chain independent opportunities and you obviously recently did one. I'm kind of curious how the economics of that type of transaction play out versus a traditional file buy?

Some parts of it are similar. The transaction we did had four for's and two operating in place kind of stores to it. So when you pulled it all together for four stores you were taking those scripts and moving them into one of our existing stores. Which really allows you to gain a lot of efficiency. And for the operates in place, you're really looking at the opportunity as an example to grow the front end business and use the tools that we have to help the pharmacy business. So - - and so you have all those things going for you when you do one of these transactions.

And we have several others that we are looking at right now to. So, we think it's a good way to help dense-up strategic marketplaces.

The other opportunity you have is what we call a reverse-for where maybe you operate an independent in place but maybe there's another store that we have that can move into that store. Move our script file into that store. That's also another example of how one of those deals can make sense.

Okay. And then can you just expand a little more as you start to build it up the PBM capabilities, sort of the timetable of where we are and what kind of costs and time frame we are talking about in terms of building an internal sales and marketing team?

Well, what we've done so far is we have really trademarked the name for our PBM, Rite Health Solutions. We are currently in the process of recruiting to fill the sales and marketing positions. And we would expect by fall to have that sales organization put together to begin to work with employers and plans. Although we could actually even before we get the full organization in place begin to do some specific work with any targeted employer because we've got all the back states taken care of through what we've done with ProCare. But really the whole intent of what we are doing with our PBM is to really be able to keep driving customers into our retail store so we have a viable alternative to mail order in our strategic market.

Okay. Great. Thank you.

You're welcome.

Your next question comes from Steve Chick with J.P. Morgan.

Hi, thanks. Can you guys here me okay?

We hear you now.

Thanks. Sorry about that. I guess I have a couple of questions. And I apologize if I've missed part of the call. But I know you guys don't discuss the profitability and sales of your regions separately. But when you used to give the data out the west coast I think was the least profitable. I think central was in the middle of the road and the east coast was your highest profit region. And with some of the west coast investments you've made over the years is there any reason to think that that split would be any different right now?

Again we don't discuss regional profitability, Steve. And I don't think we've done that in a long time or since I can remember doing this.

Many, many years ago.

Yes so, we don't do that.

Alright. Well, is it safe to say that all three regions are pretty safely EBITDA positive?

Yes.

Okay. Alright. Now second thing, just as it relates to the it installation of your new pharmacy system and - - which I think you completed I guess at the end of November how much of - - is there away to quantify with the lost customer service and the satisfaction surveys, it kind of seems like that might have had a bigger impact on your comps and a lingering effect versus some of the other issues you guys have cited. I wonder if there's a way you can quantify that? How much that might have had an effect? Is there away to do that?

Well, it's certainly harder to measure. That's pretty much an intangible kind of thing from a measurement perspective. What we tried to look at was customer service scores, kind of on a before and after basis to give us some feeling for it. And as we've said before it clearly was attachable to customer service scores. Turning that into a precise sales number is difficult to do. Quite frankly some of the other factors that we cited are also difficult to measure like the mandatory mail programs because many of them are in third party PBM's where they are hard to see. So, again, when we get into these sales discussions we are doing our best to give you as much insight as we can. But they are not always easily quantifiable issues.

But we do know that we had disruption in our customer satisfaction because we could see it in our scores because we collect a lot of customer data. And any time you have dissatisfied customers you can or you are in danger of potentially losing a customer. So we really ramped up training support around the system. We are - - like I said invested in the tech training to really make sure our techs are really first class supporters of the pharmacists. We have all the metrics that John talked about to help us make sure every store is really using the system to its full capability. And it also allows us to really get in and see how we are delivering on the customers' primary expectations, which is this timely delivery of a script. So, we really believe that it's going to help us get that much better at delivering satisfaction. And our satisfaction scores have continued to improve over the fourth quarter and then into the first quarter. So we are real committed to being the best there.

Yes. I guess where I was going with it is when we saw CVS kind of had a little bit stumble when they integrated the system. After the fact they had to be very aggressive with promotions and giving stuff away on the front end to get people back. And within your guidance have you guys - - do you think you are being - - are you engaging some of that stuff for people who I assume left if the service wasn't good? Are you being - - how aggressive are you in getting some of those people back? And how conservative are you with your guidance with that in mind?

Well do do keep track of what we call lost customers. We monitor transfer scripts. We have programs already in place that we are going to continue to run to attract customers back. And we are going to do some new initiatives too to just be able to attract more new customers. We really think improving our overall reputation is a part of that. But also any of the things we do going forward with maximizing the senior opportunity for prescriptions, which is a totally a separate issue. What we've done with our Living More senior loyalty program I think is going to be a big plus in helping us improve our business there, too, and getting customers into our store.

Steve, these initiatives are included in the guidance that we've given you.

Right. Okay. That's good to hear. And did you say where - - I guess it's kind of implied but in terms of your June pharmacy same store sales, are we at least going to see sequential improvements from I think the negatives that we've been seeing? Or do we really have to start looking real forward to that?

June pharmacy sales will be out 14 days or something, 15 days and we're waiting to see how the month finishes up here. But the trends are not a lot different than they have been over the last few months.

We will be announcing it July 5.

Okay. Well, that's helpful though. Okay. And then the last thing, I think I heard you say that you guys thought - - that you think your SG&A will improve - - the SG&A margin I think will improve within your guidance. Is that - - do you expect SG&A to be down year over year within your guidance for the year? Is that right?

Not necessarily down year over year. And there was also, I just want to caution you, there are some areas where we clearly overspent a little bit in the quarter. And we're focused on fixing that/ And part of that is that we - - part of the reason why we overspent in certain area is due to our sensitivity to sales. But as we go forward across the year there is definitely some seasonality to our SG&A. As an example the first quarter is generally lower. There is - - the last two years there has been really no holiday pay in this quarter. So the rest of the quarters have two holidays in them. That's $20 plus million of payroll and benefits type of stuff that moves around between quarters. So you just have to be a little bit careful with that.

I think what we are seeing is relative to our own plans and expectations there are some clearly some things we can do to tighten up our SG&A as we get past the first quarter here. If you look at the quarter, Steve, I mean sales, pharmacy sales were clearly softer than we expected but margins were very strong. So, where we stumbled a little is on the SG&A side. And so had SG&A been a little tighter even with the sales softer with strong margins like we have it probably would have been a little better than where we were obviously. And so we think as we look across over the next couple of quarters that could be an opportunity for us to pick up the earnings a little bit if we choose.

But I do think it's important that we still be very responsible about where we do cut costs because cutting them where they impact the customer is not what you want to. So, we, I think, are very careful in really focusing on supply chain initiatives, what we are doing around inventory management because that can help really make the labor part of handling' whether it's in the DC or the stores a little easier, too. So we are doing those kind of initiatives besides some very specific areas.

Okay. Thanks.

Your next question comes from Jody Staggs with Raymond James.

Could you talk a little about the economics of your relationship with Aetna, United and Coventry? And I guess what we are kind of curious is, is it going to be a set fee or is there just some they're going to try this back to the amount of business that can be tied to Rite Aid stores?

Now remember that - - you've read the press releases on Aetna and Coventry, I assume. And these are really marketing partnerships. And they're a preferred marketing partnership. So we are going to work with them to really get the information to a large number of senior clients to help educate them about the Medicare prescription drug benefit. And in turn they will also help educate their client space on our Rite Aid programs like our Living More. So it's a marketing partnership and it can work for both of us. And I think there is going to be an awful lot of seniors out there that need a lot of information. And the role of the drug store in doing it is really key. And I think that's what companies like Aetna and Coventry understand.

Great. I appreciate it.

Your next question comes from Ronald Phillis with Banc of America Securities .

I was wondering if you could talk a little bit about your willingness or interest in selling assets outside of sale lease backs to raise cash? Is that something that you are pursuing now, interested in, is a possibility in the near future?

Well we have a boat load of liquidity if you will.

Right.

In the near term. Again we have a $950 million revolver. And what we are really I think interested in, at this time, is growing out Company. We are investing in store growth, remodels, investing in our underlying systems and really trying to leverage our infrastructure. So the business plan that we are executing at this time is really turning into more of a growth model than anything else. And I think that's kind of where we are headed at this time.

The reason I ask is the topic du jour is, what CVS talked about in their analyst conference here in the city earlier this month, about wanting to go get into the west coast and potentially looking to you to provide them with an acquisition opportunity over there.

We don't comment on rumors and speculation.

No. And what John talked about about our growth program really we are building in our strongest markets and one of those really is California. So our goal is to grow this Company.

We are building a lot of new stores in that market. Along similar lines is there anything you can tell us about Mr. [Ikon's] new involvement in the Company? As far as involvement we know that per a report that was filed with the SEC that one of funds holds shares of Rite Aid. But it's fewer than 2% of the stock. And we don't know if the fund still holds the stock because he only has to file quarterly reports but he has not contacted the Company and we have not spoken with him.

Thank you so much. Have a good day.

Your next question comes from [Reid Cem] with Banc of America Securities.

I just had one follow-up question. Actually, John I was wondering if you could share with us based on your guidance where you think debt balances might be at the end of this fiscal year? It seems like if I take the midpoint of your EBITDA guidance and the free cash flow calculation it might be potentially 300 million out on the AR facility and kind of an undrawn revolver. If you could just comment.

Well, I think - - just probably to tackle it in a slightly different way if you use the midpoint of our guidance, cash interest expense is probably kind of 250ish and I think is what we kind of guided to do on our charts there. And CapEx on a net basis is probably less than 300, 290ish. But we'll generate some free cash flow here and we have to figure out the best way to use it. Okay?

Okay. So CapEx is actually going to be maybe 300ish?

Well, net of sale lease backs.

Net of the sale lease backs, okay. And then just one other question on the Medicaid front, I was wondering in all the various states you operate are there anywhere where we might see any type of positive developments on reimbursement? Or is it pretty safe to assume that generally there is downward pressure, perhaps compensated by some generic shift, just generally downward pressure on reimbursement?

I can't say I've heard of any real positive news coming out on any of the states on Medicaid. I think they are always looking for opportunities to reduce costs in their programs. And so we work with them as any initiative comes up in a state. And do our best to really help them understand the value of pharmacy and medicines and keeping their healthcare costs down overall.

Okay. And then I'm sorry last one. On RX file purchases, if you don't want to discuss the one you just did that fine. But the purchases that happen away from you, for example, what sort of valuations are you seeing if you looked at kind of on a percent of sales basis?

I don't know it quite that way.

Or any type of valuation metric that you might look at it. Just what are you seeing in the market?

Well, the market I think is fairly aggressive today in terms of how - - there's high market and there's a fair amount of script file bought and sold. And I would say prices are increasing years ago on script file purchases. Even at current market prices they still provide a very nice return in terms of the way we analyze them.

Each opportunity has some fairly significant differences in their variability or retention if you will depending upon the location of the old store to our store, the driving distance, whether or not the old customers have to drive by competitors, things like that. So there's a significant variability in the - - if you will, script value.

Okay. Thanks for the comments.

Your next question comes from [Ethan Lacy] with Merrill Lynch.

Good morning.

Good morning.

Just trying to sort of quantify on the UAW issue, I think in the past you guys had mentioned that the RX comps in stores of high exposure might have been hit, I think it was roughly negative 200 basis points or something of that nature. Assuming you are still quantifying that, when we think of this quarter and same store sales of negative 1.4 for the RX in Q1, can you give us a sense how much of that is UAW?

Here's what we've said and I'll try to update it for you. I think what we've said is; there are - - there is one specific UAW plan that we can see and so we took the stores that fill scripts in those plans and had some number of scripts in those plans and we looked at how those stores overall were doing. And we said that that group of stores in total were impacting our comps between, call it 1.5% to 2%, somewhere kind of in that range. As we came through the fourth quarter that probably dropped a little bit between I would say 1 and 1.5. And in this quarter it's probably between 75 basis points and 1%.

So, it's going down.

It's going down. You're right. We starting to work our way around that. Great. That's helpful.

And also, just curious also on the generic side, I think it was maybe third quarter last year you had mentioned that there was some reimbursement rate pressure on generics. How is that holding up these days? Have - - did that trend continue or are you seeing things stabilize? Has there been any change there?

Off the top of my head I would say things are probably maybe reasonably steady from there.

Last year there was a lot of multi-sourcing activity in the generic set move the backing much faster than what we had been accustomed to. And we are not seeing that right now.

And then on the SG&A side to circle back to that really quickly. Was it - - you had said later on in the year there was going to be some initiatives. And I think the commentary was, part of it was seasonal. Are there specific initiatives you've outlined on SG&A to sort of maybe curtail that in the second half of the year?

Yes, I think you can, first of all I will let Mary comment to, but there's some specific areas that we just mentioned that we are working our way through. One of them is labor. Where we have continued to probably overspend a little bit on the pharmacy side just as we, one) worked out way through the system and some script declines in certain areas. And so we are looking carefully at how we use our labor as we go forward. Again we are not laying anybody off, we're not cutting any hours, we're just trying to efficiently manage our pharmacies here as we work our way through our sales issues. So I just want to be clear about that. We talked a little bit about advertising and advertising investments you need to balance with your objectives for sales. So we continue to work in that area. There were some areas in the store expense side, certain line items where we probably overspent a little bit in the quarter. I think those we've already probably addressed as we started the second quarter. Something like the AR securitization facility, those fees are probably - - that's a great low cost facility for us. They run through SG&A but that's a great financing source for us and those fees will probably actually go up a little bit if we were to increase the utilization of that facility.

And I think the only other thing I'd to that is what I mentioned earlier' that we are just going to continue to really work on any initiatives that pertain to just supply chain economics. Because - - and that includes our inventory management programs because anything we can do to improve our positioning there can take labor out of both stores as well as a distribution center.

Great. And then last question. Can you give us a purchase price on the Shelly's stores?

On the Shelly's stores.

Yes.

No, I don't think we disclosed that.

Would you now?

No.

Okay. Thanks a lot.

Your next question comes from Alexis Gold with CIBC World Markets.

Just a couple of questions. It appears a lot of your suppliers are tending to pass through price increases as they're impacted by higher raw material and shipping costs. How are you addressing that and how are customers responding?

Well, I think you've seen price increases from suppliers in certain classifications. But I would say generally speaking we still have to be as competitive as we can with pricing and so we are - - work within the marketplace to make sure that we are competitive. And you can't always pass a price increase along. But if a certain category moves up, you are able to move up.

And then just you continue to talk about promotional and advertising spend with some new stores openings. Is it fair to think about some of your and as far as sales force ramp up, training as well. Is it fair for us to think about your '05 EBITDA, as some one-time expenses in there that we actually might recoup next year?

Our growth program really is just starting up. So, we are going to be actually opening more new stores and reloads over the next several years. But we have definitely accounted for our costs associated with doing our new stores and reloads and remodels in our projections.

But basically is you think about - - I think the first - - when you ramp a program up like we are; the first couple of years it's probably more of a cost than it is a benefit just because you have the start up costs and new stores mature over three to five-year kind of time horizon. So in the first couple of years of a program like we are doing it puts a little bit of pressure on your numbers. But then as you get some mature stores, stores developing that are making nice returns, they are more than offsetting the cost of the stores that you are developing at that time. So we are a little bit upside down probably over the next 24 months or so. But with reloads and whatnot in there, there may be some acquisitions we probably would get to a point where it's a net/net contributor. Maybe in the third year from now.

Great. And just finally as whether patterns continue to improve a little bit are you starting to see better trends in June, at least from the front end?

I think I mentioned that our front end has recovered nicely and we'd expect it to continued to so.

Thanks very much.

You're welcome.

Your next question comes from Rachel Golder with Goldman Sachs Asset Management.

Yes, thanks and I apologize if this has already been covered. So, I understand that you are ramping up the pace of growth and to get to your full year CapEx guidance you are going to have to be running at about 100 million a quarter over the next couple of quarters. Would it be fair to extrapolate that out into '06? Is there a further acceleration we might expect?

There's probably further acceleration in '06 CapEx and probably - - our fiscal '07 CapEx would probably be a bit higher.

And looking out the remainder of this year is it reasonably steady over the next three quarters that it will run-around the 100 a quarter or --?

Again, it's as I think Mary may have touched on, or somebody did somewhere along the way in this conversation, there are six stores that are opened. So you are kind of paid for, or paying most of that store now. There's another 36 under construction right now so those - - the cost of those will come rolling in over the next few months. And probably by the middle of August all the remainder of the stores will be under construction. And so that CapEx will roll into the third and fourth quarter. So it probably - - it rises across the year sequentially.

Okay. Great. The sale and lease-back pace is not very significant now, is this a financing source you may increasingly use or should we expect roughly the same pace?

I would say that it is not our intention in the long run to really own the stores. So it is going to depend on the mix of stores that we build ourselves versus what a developer constructs for us.

And could you give a sense of what percentage of your current store base is owned versus leased?

Right now today we have about 235 stores that are owned. And we own our description centers. But the rest is leased.

Okay. Thank you very much.

Your next question comes from cal Smith with Jeffries and Company.

Good morning.

Good morning. Looking at the CapEx again, sequentially rising over the year but, John, I think I heard you say you expect a net CapEx to come around 290 million.

300. Yes, right in that range.

So, you're looking for about 60 to 100 million total sale lease back transactions this year?

I think our guidance was 350 to 400 on the CapEx. So depending on where you put us in the CapEx range, maybe it's 50 million or so or a little more. 50 to 100, say.

Okay. And what was rent expense in the quarter?

We haven't got that. You'll just have to take the annual rent expense out of the 10(K) and back into it.

Okay. But that would be probably rising over the course of the year with the sale lease-back transaction?

A little bit.

A little bit but most - - over 75% of the stores are going to be recognizing recognize rent expense in the fourth quarter. So it's not, not evenly spread throughout the year.

Okay.

If you want to hang on one second I might have this number handy here if you want to be patient with me. I probably don't have the right number. I guess we'll have to - - either us back and we can give it to you or just take - - I think if you take the annual number and divide it by four you're going to be pretty close.

Okay. That's helpful. And with SG&A, generally it's a tad higher seasonally in the second and third quarters than in the fourth quarter. But it sounds like from your comments earlier that you expect it to be flattish to slightly down in the next few quarters.

No, no, what we are saying is it will seasonally be higher in the second and third quarter. That's what we are trying to say.

Okay. You're just keeping it from being even higher than that?

Yes. It does, it does go up seasonally and that is going to happen.

Okay. Thank you.

You're welcome.

[OPERATOR INSTRUCTIONS]

I think we will take one more question if there is one. If there isn't that's fine too.

Your next question comes from Andrew Ebersole with KDP Investment Advisors.

I was hoping that you could break out your same store sales guidance. I think you provided guidance of 5% to 2% comp increase for the year. And I was wondering what the composition of that would be when you look at front end versus pharmacy?

Appreciate the question. We have not done that and we did not do it in the guidance but I would just like to clarify it's actually 50 basis points to 2%.

I'm sorry, yes.

Okay. But we do not break that out.

Do you guys have a sense or are you expecting at least a positive pharmacy comps in your guidance for the back half of the year?

We do expect pharmacy comps to improve as we go across the year, yes.

Thank you.

You're welcome. I think that wraps it up. We appreciate everybody for attending our call today and thank you for taking the time.

Thank you.

This concludes today's Rite Aid first quarter conference call. You may now disconnect.